Smart traders will capitalise on this week’s FTSE reshuffle

DURING the last month the top football teams in the Coca-Cola Championship have been vying for places in the Premier League. The lucky teams are Newcastle, West Bromwich Albion and Blackpool, replacing Portsmouth, Burnley and Hull City which have lingered at the bottom of football’s top flight.

In the same spirit, the FTSE reshuffle is taking place this week. A few of the largest companies in the FTSE 250, as measured by their market capitalisations, will replace those companies in the FTSE 100 that have seen their value drop a little too much. The review will be announced on Wednesday after the market close and it will be based on the closing prices on Tuesday. The changes will be effective at from the market close on 18 June.

Based on 1 June prices, the companies that look like they will be promoted to the top flight of the FTSE will be Essar, the energy company, and Africa Barrick Gold, the mining stock. They will replace travel firm Thomas Cook and the London Stock Exchange itself, according to John Carson, an analyst with investment bank Societe Generale.

Companies can join the FTSE 100 if they rank among the top 90 companies listed in the UK based on market capitalisation, and conversely they can be eliminated if they fall to position 111 or below.

But does the reshuffle offer an opportunity for spread betters? “Some people think you should buy the companies that are getting promoted on the expectation that FTSE 100 tracker funds will have to buy the stocks, and sell the companies that are getting demoted,” says David Jones, chief market strategist at IG Index. Societe Generale estimates that the extra demand for Essar shares once it enters the FTSE 100 will be 27m shares, with 8.6m for African Barrick Gold.

GOOD PROSPECTS
However, Jones adds that there has been no definitive work done on the impact of the FTSE reshuffle on share prices. Nonetheless, it makes sense that companies that are moving into the FTSE 100 have good prospects. “It can be a good strategy to buy the companies that are getting promoted since they are obviously growing. If you buy those companies then you are moving with the market trend, which can spur further price appreciation,” says Jones.

Likewise, getting ejected from the FTSE 100 doesn’t bode well for a stock price. Already, the London Stock Exchange’s share price has fallen to 10-month lows, and Thomas Cook has fallen to its lowest level since last September.

This is because institutional investors such as pension funds tend to invest in blue-chip stocks, so companies that will be demoted could be subject to selling pressure, says Angus Campbell, head of sales at Capital Spreads. Likewise, he notes that being a member of the FTSE 100 has prestige associated with it, which can add to a stock’s attractiveness.

Jones points out that the reshuffle will tip the FTSE 100 even more in favour of energy and mining stocks, which already make up more than a third of the entire index. “This reshuffle certainly won’t help with the diversity of the FTSE 100, which will remain at the mercy of the oil and mining sectors,” he adds. BP has been instrumental in dragging down the index in recent weeks.

Although it is well trailed which stocks will enter and exit the FTSE 100, there should still be some subsequent volatility for traders to take advantage of.

FOCUS | FTSE 100: ONE UP, ONE DOWN
Essar Energy is expected to enter the FTSE 100 just a month after its float on the London Stock Exchange (LSE), having previously been listed only in India. Essar Group is one of India’s biggest conglomerates but it floated just its energy wing in the UK to fund a refinery expansion, a move which fuelled fears in the City about the robustness of its corporate governance. Even before its disappointing debut on the LSE, Essar Oil, the company’s main energy subsidiary in India, had seen its price in Bombay slip 32 per cent this year, in part due to falling oil prices­­. Its price-to-earnings ratio on the Bombay Stock Exchange remains high. Despite a first-day 7 per cent drop on the LSE, Eassr Energy’s price is now at 437p, closer to the initial target of 450p.

Ironically, Essar’s FTSE 100 entry would push the LSE itself out of the index. Its share price has dropped 17 per cent this year. This reflects stiff competition from pan-European alternatives, but the LSE claims it will take time for last year’s purchase of Borsa Italiana to pay off. It is probably right and some of its newer competitors may yet fold – but in the meantime, we are facing an ironic departure of an iconic firm from its own flagship index.